We were at a Family Office* conference, scheduled to start on March 13th, 2023, and overnight the agenda and the narrative of this conference changed, the reason? Silicon Valley Bank (SVB) collapsed!! We ended up talking about this crisis and what it means to every subject we picked up.

These recent events that led to the downfall of SVB were described as one of the saddest days in the banking and VC industry history by one of the $250M+ VC fund managers at this conference.

The concern that we see, around a $250K+ FDIC-insured deposit, seems to be just the tip of the iceberg. In this article, we try to provide you with a simplistic understanding of what led SVB to this day and highlight the bigger problem ahead, as we understand it from a completely different perspective!

Silicon Valley Bank- Establishment, Collapse, and Impact on the VC Industry.

Silicon Valley Bank (SVB) was founded in 1983, to support the startup industry. Before SVB, the banking industry did not understand the startup space, especially those who lacked the revenue. SVB specialized in sophisticated risk analysis and providing financing through low-interest loans to startup companies in the technology and innovation industry, the VC funding.

Did SVB Crisis Happen Overnight?

SVB has been a trusted partner for venture capitalists and startups in Silicon Valley for over 40 years. However, on the surface, it seems that the bank is now in trouble, with only $250k deposits backed by Federal Deposit Insurance Corporation (FDIC), and the rest in jeopardy. (Update: FDIC now announced they will back all the deposits, but the problem does not stop there). The crisis that SVB and similar banks are facing is unique to the VC industry, unlike the 2008 crisis, which was the banking crisis due to the real estate industry.

Step-By-Step Events that may have led to SVB’s Fall.

1. Venture capital funding is not easy and it has a high barrier to entry, meaning, it takes a lot of risk analysis and due diligence to provide loans to startups with high-risk profiles. SVB has been doing this successfully for over 40 years, financing startups in Silicon Valley at a very cheap cost (1 or 1.5% over the prime) Vs 18-20% from other sources. They support the ecosystem for Silicon Valley startups and more. Take a pause and think about the Silicon Valley startups that matter to you the most, it’s highly likely, banks like SVB supported that!
2. The crisis that SVB is facing did not happen overnight. As they provided the most inexpensive loans to startups, when rates were near zero, SVB invested their money in low-interest, long-term bonds, thinking it was a safe bet. At the end of 2022, SVB had $91B in a bond portfolio, out of their $211B total assets. However, the sudden hike in interest rates tipped the scale of VC low-interest leverage funding, which created a huge gap between what is financed and what SVB was earning from the bonds. The $91B bond portfolio became worth just $76B.
3. To bridge the gap, SVB announced the sale of stocks, $2.25 billion in value. With social media, this word spread like wildfire, what’s now known as a “Twitter bank run”, account holders rushed overnight and $ 41 billion in deposits were withdrawn leaving SVB at negative $1B. This created a massive problem for the bank and regulators had to step in.
4. One of the reasons why this crisis is significant is that FDIC-insured banks are allowed a 1:4 (used to be 1:8) leverage ratio. This means that for every $1 that a bank has, it can give out $4 in loans.  For the banks like SVB, this is a bigger business opportunity than lending itself. So, for SVB, the bigger book of business is the money these account holders had to keep in the bank, now and in the future when they are successful, so banks can use this for leverage/loan at higher interest rates for other purposes and have a profitable endeavor.
5. This is sustainable only when the money is kept in the bank, to use the 1:4 leverage allowed by FDIC. However, if everyone rushes to take out their money at the same time, banks may not be able to meet the demand as they have only $1 for every $4 deposit at hand. With SVB in this situation, the collapse of this long-standing institution came down the wire quickly with the “Twitter bank run” of $41B overnight!
6. Now the $250k insured limit imposed by the FDIC affects the VC industry significantly. Many startups and venture capitalists had deposited funds in SVB, trusting the bank with their money. However, with the $250k limit, this means that a significant portion of the funds deposited may not be recoverable. This is a massive blow to the industry, as many startups rely on these funds to keep their businesses running in terms of liquidity, payroll, and other business expenses (if you are a syndicator in Real Estate, imagine your property accounts are recoverable for only $250K, will you be able to survive that property or the business?)
7. The trickling impact could have been even bigger on an already weaker economy if the payroll could not be achieved. FDIC provided an update that they will support all deposits, even larger than $250K+ which is a huge relief but the problem does not stop there.

But wait! While it may seem like FDIC has insured all deposits, even over $250K, the doors are open for SVB, regulators have stepped in and are working on the sale of SVB, this is nowhere near to having control, it’s like applying a temporary band-aid to the situation.

Why are the users thinking of depositing the money back to SVB?

First of all, the worst part is, the account holders who rushed to withdraw their funds and have their funds moved over to safety, are now in a peculiar position to put that money back in SVB, wait what? Why?

Well, one of the big bold clauses in the loan terms with SVB, is that the account holder will keep the money in SVB, the moment they rushed to take it out, now they are in default of the loan clause, and hence the loans will become due. Can they afford that for their Multi-Million Dollar loans?

So those who rushed to withdraw now have a difficult decision to make within the 10-day grace period, to return the money OR the loan!! What’s easier to return, the liquid cash or the loan amount, will the institution that they moved money to, be capable of giving them the high complexity loan within 10 days? Tricky right!! Unfortunately, that’s the reality of the situation.

SVB Portfolio Quality

Now let’s understand the quality of SVB itself and the portfolio they have, just because it failed, does not mean that it’s a can of worms.

1. SVB portfolio is of high-quality performing loans, nothing is wrong with this VC capital funded itself (again compared to Real Estate, with quite a few CRE-like multifamily stuck in bad loan situations currently, the quality of asset is compromised, not in this case, these are high performing loans). These are now up for grabs at huge discounts.
2. The infrastructure for SVB is really strong, they operated for 40+ long years and survived many market cycles, and were a trusted bank for many, for a reason, before these sequence of events occurred.
3. This is strong, however, a complex portfolio, as VC space is quite a complex space to understand and exist, in terms of proper risk analysis and to support this funding.

Why is the Sale of SVB, not an easy task?

There was a failed attempt over the weekend to auction SVB, let’s understand why this takeover is difficult. The bank has a unique set of clients, and finding a buyer that can handle this is not an easy feat. Moreover, with the current situation, the bank’s value may have decreased, making it less attractive to potential buyers. At its peak the stock value was close to $700 and is now hovering at $100, this is a sinking ship, irrespective of the high-quality portfolio.

Selling At A Loss

A few questions are being raised by the sale of this institution, which was once known for its high quality:

1. The institution’s portfolio of thousands of VC loans is held by SVB, who possess the necessary expertise to evaluate and manage risks associated with such loans. Who among the potential buyers possesses similar expertise to take over this VC portfolio?
2. If there is no single entity with sufficient strength to take over the institution, will its assets be dismantled and sold at a discounted rate?
3. An interim third party may take over the reins of the institution, but the question remains for how long can they sustain this arrangement?

The big(ger) question(s)

FDIC has announced that they will back ALL deposits made with SVB, even if they exceed the standard $250,000 limit. However, SVB is just one of many banks facing this issue in the VC space, with others like NY Signature also falling into this crisis, this situation raises concerns about the stability of the VC industry.

1. The crucial question is whether the FDIC will have to continually intervene and rescue failing banks during this crisis. If so, it begs the question of how much funding will be required, and whether they will be able to sustain the guarantee of $250,000+ deposits. Does it remain to be seen how long the FDIC can continue to bail out the banks?
2. Another significant question to consider is why SVB, the bank, which was relied upon for over four decades due to its dependable infrastructure, successful management of high-risk VC funding at a low cost, and the support it provided to flourishing startups through various market cycles, failed to anticipate the risks posed by high-interest rates on the horizon. Is there any action that they could have taken differently to remain a substantial institution and continue to support startups as they did before? Perhaps they could have charged slightly higher interest rates while still keeping them manageable.
3. An even more pressing question is who will take over and continue the vital role that SVB played in providing VC funding, particularly in Silicon Valley, which is a hotbed of innovation. Even if we can temporarily address the current SVB situation, the long-term implications are significant. Who will fill the gap in VC funding in the future, will there be a hole created in the VC funding space?
4. Furthermore, what kind of changes will this crisis bring to the VC space, the banking industry, and the FDIC? Will there be alterations to the rules surrounding FDIC-insured deposits, such as the leverage proportion that banks are allowed?

Conclusion:

The collapse of a bank like SVB can have a ripple effect on the banking industry as a whole. As banks become more cautious about providing VC funding, this can create a domino effect, with startups struggling to secure the funding they need to keep their businesses running. This, in turn, can lead to a slowdown in innovation and a less dynamic startup ecosystem, with potentially far-reaching consequences for the wider economy. The crisis that SVB is facing is a significant blow to the VC industry. While navigating the aftermath of this crisis, it is crucial for the banking industry to learn from the mistakes made by SVB and work towards a more stable and secure financial system.

The ripple effect of the SVB crisis is likely to be felt for years to come, with significant implications for the VC industry and the wider economy.

What does it mean to you and should you take measures proactively?

We will wait and watch how this unfolds for the VC industry. As a consumer of the banking industry, however, everyone is asking,

“How does this impact me and my hard-earned savings?”
I am sure you have had that question too.

Today, more money is waiting on the sidelines than in investments, mostly waiting with banking sectors and money market accounts. Do you have more than $250K with one bank?
The big question to ask yourself:
Is this money safe or even worse, eroding to inflation while waiting?

We at Think Outside The Stocks are always big proponents of diversification, and this is more important now than ever. Take a hard look at where your assets, especially your savings are allocated, diversification is key. It only helps to have a stitch in time and start reallocating/diversifying your investments and apparently your savings too.

We provide risk-managed investment options to diversify in commercial real estate investments and further, savings alternatives other than the traditional bank, with the Infinite Banking system that has been trusted for over 150 years. Both of these options are completely passive and hassle-free.

Connect With Us

Just reach out to us if you want to learn more, see if this is a right fit and start exploring your options today because apparently, things can go south over a weekend as it happened with SVB. Schedule your call today!